Should I create an LLC for my rental properties?

The case for (but mostly against) creating and maintaining an LLC for managing your rental properties

should i create an llc for my rental properties?

Last updated on January 5, 2022

Over the course of your real estate investing journey, you may have heard of others talking about using "LLC's" (limited liability company) in some way relating to their rental properties. If you've done any amount of research, you'll be sure to find a large number of sources telling you that you need an LLC for your rentals, while others are going to insist that you don't need an LLC for your properties.

The answer to this question largely depends on your specific situation, considering different factors such as which state you are in, how many properties you own, how risk-averse you are in regard to personal liability, how many members you have in the LLC, plus much more. Please remember that each state has its own laws regarding businesses and LLC's, so you'll need to do some homework to discover the absolute specifics of LLC's and how they relate to you.

Long story short, you'll most likely opt not to form an LLC for your rental properties. Let's look at why this is by first understanding some basics about LLC's.

"LLC" stands for limited liability company. It's called this because an LLC does indeed offer some degree of protection for the individual member of the LLC. For example, if you were to ever come under legal action from a tenant, visitor, or another aggrieved party, they would have to bring the action against the LLC instead of you personally. Sounds good, right? There's more to that than you think. More on this later.

Along with the limited liability, an LLC also has some other aspects, including:

  1. Pass-through taxes
  2. Separation of personal & business expenses
  3. Anonymity
  4. Splitting ownership with partner(s)

Let's go through each of these aspects in order to determine whether having your rental properties in a LLC will be worth it for you.

First, let's go over the "shield" of limited liability an LLC offers. Expanding on the example above, if any legal action were to be initiated, it would have to be brought against your LLC instead of you as an individual. This is because if you set up an LLC for your rental properties, you're essentially saying it's not you that owns the rentals, but instead it is the LLC as an entity that owns those properties. This sounds attractive, but there are more than a few ways a persistent party can get through this layer of protection. For example, claimants can try to "pierce the veil" between you and your LLC, asserting that there is no tangible difference between you as an individual and your LLC.

One of the primary benefits of having an LLC is taxation, more specifically the pass-through taxation that is frequently touted as a nice perk for LLC's. Pass-through taxation means that the LLC itself does not get taxed, instead, the taxes "flow" back to you as the individual. This means that theoretically you'll avoid getting double-taxed where your LLC pays taxes as well as you as an individual. However, when it comes to rental properties, the real tax advantages come with depreciation and deductions, both of which are independent of having an LLC and can be taken advantage of by owning your properties in your own name. So, take this into consideration since you'll need to deal with additional paperwork if you do go with an LLC.

Next, let's take a look at the separation between personal and business finances and LLC's. While it definitely can help when you've got a tidy distinction between your own personal finances and those of your business, an LLC isn't required to achieve this as there are now multiple accounting methods and solutions available that can help you keep your finances simple and clean.

But what about anonymity? These days, it's very easy for anyone with an internet connection to snoop around and find out some personal information you may not want. Since LLC's are entities separate from you as an individual, they can offer some degree of protection when it comes to public information. However, it's become increasingly easy to uncover the identity of the LLC owner using software or just some detective work. This is something to keep in mind as you weigh the benefits of an LLC versus the effort of creating and maintaining an LLC.

Finally, there's the consideration of partners within LLC's. The short answer is that it will indeed make it easier to split ownership of your rentals with a partner or two if you form an LLC. However, there are a few other things to keep in mind when it comes to LLC's and your rental properties.

Obtaining a mortgage and financing for acquiring new rentals can become more difficult if an LLC is involved. This is because banks will typically look at historic income and profit, which a newly-formed LLC won't have much of. Also, banks usually only make commercial loans to businesses, which likely will not have as favorable of rates as a conventional mortgage that you are likely accustomed to. One more thing to consider is that while you are able to acquire the new property and then transfer to your LLC, doing so may trigger additional title transfer taxes as well as accelerating the terms of your financing. Be sure to check your state laws to find out.

That was a lot of information! To sum it all up, just remember that there are very real pros and cons when it comes to LLC's in the context of rental properties, and it may or may not be beneficial for you and your specific situation. Make sure to check your state and local laws, and consult an accountant or attorney (but remember that they're in the business of matters like this so keep that bias in mind). Good luck!

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